Chapter 1 Introduction to Macroeconomics University of Alberta

What Macroeconomics is About Macroeconomics is the study of the structure and performance of national economies and of the policies that governments use to try to affect economic performance.

Issues Addressed by Macroeconomists What determines a nation’s long-run economic growth? What causes a nation’s economic activity to fluctuate? What causes unemployment?

Issues Addressed by Macroeconomists (continued) What causes prices to rise? How does being a part of a global economic system affect nations’ economies? Can government policies be used to improve economic performance?

Long-Run Economic Growth Rich nations have experienced extended periods of rapid economic growth. Poor nations either have never experienced them or economic growth was offset by economic decline.

Increased Output Total output is increasing because of increasing population, i.e. the number of available workers. Increasing average labour productivity: the amount of output produced per unit of labour input.

Rates of Growth of Output Rates of growth of output (or output per worker) are determined by: rates of saving and investment; rates of technological change; rates of change in other factors.

Business Cycles Business cycles are short-run contractions and expansions of economic activity. The most volatile period in the history of Canadian output was between 1914 and 1945.

Recessions Recession is the downward phase of a business cycle when national output is falling or growing slowly. Hard times for many people A major political concern

Unemployment Recessions are usually accompanied by high unemployment: the number of people who are available for work and are actively seeking it but cannot find jobs.

The Unemployment Rate The unemployment rate can stay high even when the economy is doing well. After eight years of economic growth, in 2000, the unemployment rate in Canada was near 7%.

Inflation When prices of most goods and services are rising over time it is inflation. When they are falling it is deflation. The inflation rate is the percentage increase in the average level of prices.

Effects of Inflation When the inflation rate reaches an extremely high level the economy tends to function poorly. The purchasing power of money erodes quickly, which forces people to spend their money as soon as they receive it.

The International Economy An economy which has extensive trading and financial relationships with other national economies is an open economy. An economy with no relationships is a closed economy.

The International Economy (continued) International trade and borrowing relationships can transmit business cycles from country to country.

Exports and Imports Canadian exports are goods and services produced in Canada and consumed abroad. Canadian imports are goods and services produced abroad and consumed in Canada.

Trade Imbalances Trade imbalances (trade surplus and deficit) affect output and employment. Trade surplus: exports exceed imports. Trade deficit: imports exceed exports.

The Exchange Rate The trade balance is affected by the exchange rate: the amount of Canadian dollars that can be purchased with a unit of foreign currency.

Macroeconomic Policy A nation’s economic performance depends on: natural and human resources; capital stock; technology economic choices made by citizens; macroeconomic policies of the government.

Macroeconomic Policy (continued) Macroeconomic policies: Fiscal policy: government spending and taxation at different government levels. Monetary policy: the central bank’s control of short-term interest rates and the money supply.

Budget Deficits The economy is affected when there are large budget deficits: the excess of government spending over tax collection.

Budget Deficits (continued) The large budget deficits of the 1980s and early 1990s are unusual. Borrowing from the public might divert funds from more productive uses. Federal budget deficits might be linked to the decline in productivity growth.

Aggregation Macroeconomists ignore distinctions between individual product markets and focus on national totals. The process of summing individual economic variables to obtain economywide totals is called aggregation.

What Macroeconomists Do Macroeconomic forecasting Macroeconomic analysis Macroeconomic research Data development

Macroeconomic Forecasting Macroeconomic forecasting – prediction of future economic trends - has some success in the short run. In the long run too many factors are highly uncertain.

Macroeconomic Analysis Macroeconomic analysis - analyzing and interpreting events as they happen – helps both private sector and public policymaking.

Macroeconomic Research Macroeconomic research - trying to understand the structure of the economy in general – forms the basis for macroeconomic analysis and forecasting.

Economic Theory Economic theory: a set of ideas about the economy to be organized in a logical framework. Economic model: a simplified description of some aspects of the economy.

Developing and Testing a Theory State the research question. Make provisional assumptions. Work out the implications of the theory. Conduct an empirical analysis. Evaluate the results.

Data Development Macroeconomists use data to assess the state of the economy, make forecasts, analyze policy alternatives, and test theories.

Data Development (continued) Providers of data must: Decide what types of data should be collected based on who is expected to use the data and how. Ensure the measures of economic activity correspond to economic concepts. Guarantee the confidentiality of data.

Why Macroeconomists Disagree A positive analysis examines the economic consequences of an economic policy, but it does not address its desirability. A normative analysis tries to determine whether a certain economic policy should be used.

Why Macroeconomists Disagree (continued) Economists can disagree on normative issues because of differences in values. Economists disagree on positive issues because of different schools of thought.

The Classical Approach The invisible hand of Economics: General welfare will be maximized (not the distribution of wealth) if: there are free markets; individuals act in their own best interest.

The Classical Approach (continued) To maintain markets’ equilibrium – the quantities demanded and supplied are equal: Markets must function without impediments. Wages and prices should be flexible.

The Classical Approach (continued) Thus, according to the classical approach, the government should have a limited role in the economy.

The Keynesian Approach Keynes (1936) assumed that wages and prices adjust slowly. Thus, markets could be out of equilibrium for long periods of time and unemployment can persist.

The Keynesian Approach (continued) Therefore, according to the Keynesian approach, governments can take actions to alleviate unemployment.

The Keynesian Approach (continued) The government can purchase goods and services, thus increasing the demand for output and reducing unemployment. Newly generated incomes would be spent and would raise employment even further.

Evolution of the Classical-Keynesian Debate After stagflation – high unemployment and high inflation – of the 1970s, a modernized classical approach reappeared. Substantial communication and cross-pollination is taking place between the classical and the Keynesian approaches.

Unified Approach to Macroeconomics Individuals, firms and the government interact in goods, asset and labour markets. The macroeconomic analysis is based on the analysis of individual behaviour.

The Unified Approach (continued) Keynesian and classical economists agree that in the long run prices and wages adjust to equilibrium levels. The basic model will be used either with classical or Keynesian assumptions about flexibility of wages and prices in the short run.

End of Chapter